The Mother of All Housing Booms

Happy Birthday America. Here’s wishing you better political leadership in the next four years, although we’re not betting on it.

In the markets, yesterday was ugly. Coal stocks—the ones that led the market last year on rising spot prices—were sold as spot prices fell by 10%. Iron ore stocks were down too. Even energy stocks took a beating. Gabriel’s 5,050 level on the All Ords wasn’t tested.

In Europe, the ECB’s point-man Jean Claude-Trichet hiked the short-term rate to 4.25% but said the bank had no further “bias” regarding inflation. If Glenn Stevens and the RBA decide yesterday’s retail sales figures were alarming (and if the CPI figure due out later this month is even worse than the RBA expects) Aussie rates may go up again.

But it will depend on which data the bank pays attention to. Australian Financial Group (AFG) issued a press release yesterday claiming Australia is in a “mortgage recession.” AFG said that according to its data, there have been two consecutive quarters in Australia during which mortgage sales experienced “negative growth.” That may be another way of saying mortgage sales fell.

AFG’s sales director Mark Hewitt says, “Interest rates are higher and the cost of money has risen because of the sub-prime crisis in the US, which has spread to the rest of the world…It means borrowers are really sitting on their hands and holding back in terms of major purchases like buying a home.”

Without new buyers coming into the market, it will be interesting to see what house prices do the rest of the year. Individual sellers are always reluctant to lower their asking price. They believe higher prices are always just around the corner. Builders and developers are quicker to cut prices so they can liquidate inventory. More on housing below, with plenty of reader mail.

About the only encouraging aspect of this week’s trading is the noticeable decline in sentiment (and civility, judging by the mail bag). A palpable sense of fear in the markets means two things are more likely. First, investors will eventually realise that the financial industry is not going to lead the market up (whenever the market starts going up again.) The sector that performs best in one bull market hardly ever repeats its performance in the next one.

Meanwhile, the broad selling in the markets leaves many sound businesses with healthy balance sheets selling at enticing valuations. But you will have to be patient, as well. Stocks, like houses, can spend years wandering in the wilderness producing no real-return, depending on when you enter the market. We think it’s going to be painful for the S&P 500, but not so bad for a carefully selected portfolio of Aussie shares.

There’s no doubt there will be earnings in the resource sector. The huge increases in iron ore and coal prices may even generate a series of trade surpluses. The Australian Bureau of Statistics reported yesterday that May’s trade deficit was $957 million. This was disappointing in light of April’s modest $12 million surplus—the first monthly surplus in six years.

But in a separate note, the ABS said its figures did not include the new price for iron ore. It said once that starts to kick in, you may even see the Australian economy run off a string of monthly trade surpluses. This despite the fact that import volumes are growing faster than export volumes. It’s the dollar figures that count. With rising resource prices, the dollar volume of exports is obviously going up.

Will it stay there? That’s the worrying question for resource producers. We’ll keep our eye on the spot markets (where coal is already falling). It’s possible next year’s contract price for iron ore could be lower than this year’s. A lot depends on whether global industrial production slows down due to high steel and energy prices.

What does it mean for shares?

Well, if spot prices fall back towards contract prices for bulk commodities, the shares are going to come back too. But that’s the point where we think you can enter into some long-term positions in good stocks. The risk?

That’s simple. The big risk is that all the plum earnings for resource stocks have already been had, or are priced in to the shares…and that from here on out…it’s nothing but rising operating and energy costs and reduced demand. Obviously, we still like the long-term prospects for the resource sector…or we wouldn’t be here writing about it.

Have we contradicted ourselves on oil? Normally we’re happing to print critical letters. But we got one this morning one was so foul and filled with expletives that no matter how we edited it, we couldn’t reproduce it. Take out the swear words and there was nothing left. But the general point of the letter was that we are trying to have it both ways on oil…and that we are self-contradicting worthless morons who probably cross dress.

First, we make the claim that global oil production is peaking and will probably never exceed 94 million barrels per day and that in the long-term, prices will rise. Then we say we think prices may have topped for the year near US$145. Is that contradictory? Indecisive? Clueless? Who’s writing the DR, Hamlet?

We wouldn’t change a word on our oil call. The great thing about financial markets is there is no room for subjectivity in performance. You are either right or you are wrong. Your stocks either go up or they do not. There is no hiding.

With oil, you have the entire planet reconsidering its relationship with oil and deciding it is willing to pay more. It has to. But you also have some early and high-profile economic casualties of the oil price. It’s clear that high energy prices are already eating into demand. All things being equal, high prices will reduce demand over time.

The gaping flaw in our theory is the value of the U.S. dollar relative to tangible things. A weaker dollar means higher oil and gold prices—regardless of the damage high oil prices do in the real economy. Eventually, there comes a point where oil producers and consumers will decide they need to trade the stuff in a currency that’s more stable. But that too, is a big change in the markets and won’t happen quickly or without some major volatility.

One other possibility is that we are in the early stages of a global hyperinflationary melt up. Prices have gotten beyond the control of central bankers. Driving by tight supply, soaring demand, negative real interest rates, and a world currency system that’s pegged to the dollar, prices for real things will spiral out of control while prices for financial assets plummet. If that’s the case, well then our oil call looks stupid. But if that’s the case, there is going to be a lot more to worry about than the oil price.

In any event, there are cycles within cycles, even in a bull market. Right now, we think oil will go lower and not higher in the next six months. But we sill have plenty of energy shares tipped in both our newsletters and for very good reasons.

More housing news. An economist from a bank which makes money by making huge home loans is forecasting “the mother of all housing booms.” That would presumably include a lot of new home loans made by his bank.

“A growing housing shortage is setting the scene for the mother of all housing booms,” says ANZ senior economist Paul Mr Braddick in today’s Sydney Morning Herald. “Demand has accelerated and rising immigration, both permanent and temporary, shows no sign of abating. Meanwhile, rising interest rates continue to stymie any building recovery. Underlying housing demand is already outstripping new supply, and the gap is set to widen sharply, driving pent-up housing demand to record levels.”

No luck yet on our search for accurate statistics on Australia’s supply of new and existing homes. We’ll keep searching. But there’s plenty of reader mail on the subject.

“The housing shortage in Australia is really based on Govt policy. Increase immigration – create shortfall – costs go up – those with houses become wealthier, those without miss out. Problem is of course, you can’t stop the merry-go-round, even though increasing numbers are being thrown off.

John.

“I reckon it’s just a case of percentage of income going to housing (which seems to be growing daily). My gut says it’s beyond the pain threshold and so, many people are just so frustrated that they will wait, or be scared s-less (a technical term). I’m waiting, and I’m scared, and thinking of moving to the US. Most of my clients are in Europe and I can live MUCH more cheaply in North Carolina and still service those clients. A house there (US$180,000) or an equivalent one (if there is such a thing) in Perth (AUS$650,000). Hello, Mr. Rocket Scientist!!! Cheers/Jim

Dear DR,

For some 2-3 years it has been less expensive to buy a house + land package in Melbourne than it is to buy just the serviced land alone in Sydney! And the incomes in those two major capitals are not that dissimilar. It has to do with the raw land to begin with, but also the on-costs to develop it and yes, house construction costs are somewhat cheaper in Melbourne compared to Sydney.

For example, we have a 142-lot project with a planning permit in Bacchus Marsh 40km west of Melbourne and our holding costs are a mere $431,428 per hectare. On 10 June 2008 it was announced that a major developer sold 43 hectares at Doreen near Whittlesea for $802,325 per hectare but even those sort of costs are unheard of in Sydney.
And as for the difference in development costs and Council charges between those two cities, anyone you talk to in Sydney just laughs and cannot believe they can be so polarised and far apart.

This may be one reason Melbourne is attracting the lions share of immigrants @ 1,100 new people per week, mostly skilled workers, and who still have extreme difficulty in getting a roof over their heads ~ to rent or buy.

Ken M.

I just couldn’t let the drivel submitted by John H go by without some comment. John H is obviously very, very young, or in real estate. You have to be very young not to remember the pilots strike, and the subsequent catastrophic effect on house prices, and other stuff. At that time Cairns Port Douglas had been enjoying(?) an extraordinary boom in house prices. Then after that infamous clash of egos, the crash!
What was so destructive about that was not that properties lost up to a third of their value in the short term, but in spite of all the real estate hype of how you never lose on housing, and the same chorus every year that the market had bottomed and now was the time to buy. The decline continued for 10 years. Each year for 10 years properties were worth less than the year before.
Several
years after the latest boom, fnq caught up. Now prices in some parts of Cairns are down 20% in three weeks. And with some developers offering a free plasma tv for a twelve month lease on a home unit, this may start to look familiar. I’m sure that the response is that long term blah blah. That didn’t help the large numbers of developers, builders, home owners and yes real estate agents, who lost large and long. And many went bankrupt.

What’s significant at the moment is that although prices have not dropped generally by any significant amount, there seems to be a real shortage of serious buyers. That is always the first stage. Nobody thinks that they will drop their asking price until it gets to the point that they can no longer wait to sell. The real question now is if the market is going to keep firing, where is the momentum going to come from. It’s not a value thing, merely a confidence trick. Now that there are eminent mainstream authorities predicting that housing in Australia will at least 20% in the next 2 years, where is that confidence going to come from.
If the Australian market is so different from the rest of the world, where is the precedent? This latest boom in r/e is unprecedented in my fifty odd years. Didn’t it coincide with the world wide boom, or was that just coincidence? John H (not the same one)

“Dan:

I am a long time Strategic Investment subscriber and an expat American (St. Louis) living in Auckland NZ. I came down under about a year before you. I don’t know about the Aussie housing market but I have an opinion on the NZ housing market which I suspect is similar. In my opinion, the high price of housing down here is driven largely by the high price of land. The price of the land is unusually high because the quantity of developable raw land is restricted by zoning laws. Unlike the US where high density zoning is hard to obtain, low density housing is largely not permitted in NZ. Governments will not open up rural land for residential development until the existing residential land has hit a certain density. This maintains a level of government induced scarcity as well as preventing group home builders from achieving any sort of scale.

Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

Aust & NZ real estate is driven by asset inflationary expectations. Land supply restrictions (incl infrastructure taxes) & Howard discovered demand boosts (immigration) are just toppings. The bankers understand it, the state government stamp duty junkies understand it, and Joe average has until now reckoned rightly that the big end of town won’t let him down. Now that they can’t pour the liquidity into the pot from foreign funny money you get all these desperado bankers trolling our reserve bank’s reserves, future SWF fund and the latest is the ACTU & ANZ spruiking alliance to access regular super for RMBS… Read more »

Hey Ross, you seem to know a thing or two. What I’d like to know is how does the Reserve Bank lifting its target rate (selling securities) tighten credit conditions, when they are, it seems to me, loosening credit by the use of repo’s, taking all these CD’s, bank bills, RMBS’s and whatever else as collateral for cash loans? As far as I can tell the Reserve’s open market operations (targeting the cash rate) work in the same way as any of the ‘special’ loan facilities i.e. they buy, sell or loan securities. Furthermore, the only reason I can see… Read more »

Hey Justin … I will defer on the mechanisms and watch for other comments with interest. The Reserve might tell us under Chatham House rules that they didn’t have any choice but to do what they have done, the foreign RMBS hit term and the foreigners wouldn’t recycle it, the Reserve are also getting ready for the foreign bank local branches to pull the pin on the hot money that the local corporates have been swathed in. What you are on to however is the lie is that it won’t have any affect and what I was contending is that… Read more »

This is interesting stuff, and beyond my simple capabilites, real estate to me is supply and demand, and if you cant afford it you wont buy it especially with the credit card payments for petrol. To the long term investor what about all the rural drought ridden properties, this little bundle looks like it is close to collapse. Especially with the insipid rescue package for the murray darling. There will be a lot of walk offs me thinks over the next 12 months. Add to that the margin calls on lower share prices and the tanking of real estate values,… Read more »

I am a recent recruit to the Daily Reckoning having had it recommended to me by a colleague. I appreciate the frank nature of the discussions and a clear attempt to peer through the fog of economic (mis)-information. I believe we experienced the pricking of an asset bubble last year. I believe that all assets are being re-evaluated in the global economy, and just as in the U.S, U.K, and Europe, there will be a crisis in housing here in Australia too. It is inevitable as the valuation ratios to earnings are unsustainable. When it starts, it will accelerate rapidly,… Read more »

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